Doug Kass recently predicted the S&P500 stock index will finish the year at 920. It is currently right at 1000 (on September 2, 2009). I agree with the prediction of 920 sometime in the next couple of months. I think 900 may be possible and even lower to 875 based on the bottom set in July. But unlike Kass, I think the market will rebound by year end. I will wait for signs of a possible rebound once this current drop (begun last week) is further along. The signs of the bottom to this dip will be a stall in the decline just as the recent market top was shown by a stall or resistance around 1040. The rebound will happen when the market goes up on bad news. I think that may happen during the Q3 earnings season the middle of October into early November. I am still thinking that 1200 is a possibility by year end. This would completely retrace the panic selloff starting from the Lehman collapse on September 15, 2008. So, if we wait until 900 to redeploy our cash raised the past few weeks, that could provide a nice 33% finish to the year.

Where Kass is probably wrong, along with many others on Wall Street, is that there are just too many people with a bearish market view. There is virtually no one on the financial networks (CNBC, Fox Biz, etc) today saying that the selling should be ignored and the market will go much higher. There are just no Bulls as far as I can tell. The market always confounds the consensus position. It has to in order to work. If there are a majority of bears, then by definition, there is hardly anyone left to sell. Once all of us who had our finger on the trigger, pull the trigger, there isn’t anyone left to sell. So, I think the decline will be shallow and the market will rebound in 6-8 weeks. This can’t be like the panic last year because all the retail investors that bailed out in the fall and winter are still on the sidelines. People who sold everything in January and February never got back in.

There are a lot of factors to a panic that are missing right now (as they usually are, fortunately). To get a true financial panic, first everyone must be euphoric and unaware of or discounting trouble. Then when the decline starts because the market just can’t go any higher (everyone who is going to buy has bought), investment holders must be forced to sell at any price by margin calls or other financial misfortune. Last year, there was a cascading of events that are no longer in play. Most importantly, the leveraged, collateralized securitization market, the core of the trouble, is almost completely unwound (except CMBS, which is where there is still concern). The leverage in 2007-08 was in the carry trade, which is what caused the dollar to soar and interest rates to drop when foreign currencies were sold and dollars bought to cover margin calls. The securitized loans are mostly back inside the big banks now with backing by government guarantees or in private hands where they have been de-levered which allows them to be held to maturity, if needed. So, there are no large institutions needing to dump stock or other financial instruments into an illiquid market to raise money to stay afloat. That is a big and significant change.

On the way down, I am using portfolio hedges to protect my positions. I like the SP500 Double Inverse fund by Proshares, with ticker SDS.

I like this ETF because it is a double short of the SP500, which is a pretty basic / broad index of the market and includes all the big financials, techs and energy companies. I also hold another hedge, hte Proshares product called DUG. DUG is basically the double inverse of the energy market, something like IYE but with a little Materials exposure too.

I use it to hedge all my Materials and Energy exposure, although I also use covered calls for this on stocks like Suncor that have good premiums. I also have used covered call options on the Canroys, but the premiums are not very good because of the large dividends. It is just an alternative to outright selling them.

Even though it has become popular, I don’t do those Direxion 3X ETFs. They are just too wild for my taste. Even the doubles are a little scary and I am careful to keep my exposure balanced with opposite long positions. I don’t bet naked short, even now when I am pretty convinced the market is going lower. The market always goes up in the long run, so being short should be very tactical and short term. I don’t want to get caught on the wrong side of that trade.

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